18 January 2011

A very poor deal

The Great Pensions ‘Swindle’ by Arthur Seldon (*) was published in 1970. I have never found this book at all easy to read, as Arthur Seldon was himself a politician and finds various arguments for and against different forms of taxation and redistribution far more meaningful than I do, as they depend on many unexamined assumptions.

However, in the course of discussing some past debates, he draws attention to two fundamental weaknesses in the state pensions system.

(1) That universal pensions could not be affordable at the proposed level if the annual out-payments had to be taken from taxation on a year-by-year basis, i.e. if no cumulative fund were built up to provide a capital basis, out of the income of which pension payments would be made.

Beveridge, in 1941, said at one point:

“It seemed to me right to make pensions as of right ... genuinely contributory; for pensions there must be a substantial period of contribution.”

The “substantial period” he recommended in the Report was 20 years. This advice [i.e. to build up a fund] was ignored. (p. 58)

People were misled, at least initially, into believing that they were paying into a contributory scheme, and that what they eventually received would reflect what they paid in.

However, Arthur Seldon’s book makes it clear that this was never in line with the ideas of many politicians. Should people be able to get better state pensions by contributing more? That was a controversial idea even then, and by now surely few would support it openly.

(2) The other way in which the state pension scheme was always a swindle (on the electorate by the government) was that the contributions paid in would have been enough to pay for much higher pensions. People are seldom aware of the potency of compounding interest, and if money is invested and the interest ploughed back as increments to the original capital, over a period of years the original capital is multiplied by a factor which is surprising to the unsophisticated.

I have done a rough calculation of this effect, and it comes out that if you save one tenth of your salary (assumed constant for simplicity) for 40 out of 45 years, compounded at 5%, then at the end you will have saved a capital sum capable of generating (at 5%) about 75% of your salary in perpetuity. By contrast, what the state currently takes in as National Insurance contributions is well in excess of 10% of people’s salaries, whereas the basic state pension it pays out is equal to only about 20% of the average national wage.

In 1970, Seldon’s comments on the Crossman scheme which was then proposed, included the following:

The only thing that is clear is that most people would be paying, as tax-payers and consumers, more than they think they would as employees. Young people especially will be paying in contributions for 30 or 40 years that could have brought them really high pensions if invested at high yields of interest. (p. 78)

The relevant departments of my unfunded independent university are effectively censored and suppressed. They have been prevented for decades from publishing analyses of the complex issues involved, while misleading and tendentious representations of them have continued to flood out from socially recognised sources. I hereby apply, for financial support on a scale at least adequate for one active and fully financed university research department, to all universities, and to corporations or individuals who consider themselves to be in a position to give support to socially recognised academic establishments.